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Big Option Trade on BKX Today

|Includes:KBE, Market Vectors Bank and Brokerage ETF (RKH), XLF

Following yesterday's blog entry where I mentioned that the Bank Index (BKX) (NYSEARCA:KBE) (NYSEARCA:RKH) (NYSEARCA:XLF) was looking strong following a long period of stagnation, we saw a big spread trade on the BKX today.

According to livevolpro data, there was a spread that traded 3880 times on the ISE exchange on the BKX index at around 2:45 pm est today.  This was a horizontal calendar spread with the January 45 Call and the February 45 Call, with the BKX around 45.30 at the time.

Based upon the prices that the spread was done (0.96 on the Jan Call, 1.91 on the Feb Call), it looks to me like this large trader Bought the Jan Calls and Sold the Feb Calls.  The mid price on the Jan Calls was 92.5 cents and for the Feb Calls it was 1.95.  This makes the spread worth around 1.03 at the time, and they look to have sold it for about 0.96 net.  They gave the Market Makers around 0.07 worth of "edge" based on these approximations.

What does this Calendar Spread look like on a Profit/Loss Graph?  Well, this is a Long Gamma, Long Theta, Short Vega trade assuming this is a standalone Horizontal Calendar Spread.  Remember, these January options expire on the 15th -- they are paying time premium on the January Calls, which were 0.30 in the money at the time (therefore 0.66 time premium/volatility).

Considering the Long Gamma/Theta & Short Vega, it looks like they need the stock to move quickly.  A rise up would be the best case scenario, because then Implied Volatilty/Vega would go down (usually when stocks rise, option volatility drops).

For example, using OptionVue, if the stock remained flat at 45.30 and volatility also flat through Jan 15th Expiration, this position would lose around $270k.  This is due to the rapid decay to 0 in the time premium in the Jan Calls, while the Feb Calls will still hold value.  However, if the BKX rallies to 47.5 on Jan Expiration for example, this position may gain around $40k.  And IF volatility also drops 5% on the options, you then are up to a theoretical $116k profit.  On the downside, if BKX drops to 42.5 on Expiration, this makes a theoretical profit of $39k with flat volatility.  However, if volatility then rises 5% (usually implied volatility rises when a stock drops), it turns into a 39k LOSS.

You can see that these horizontal calendar spreads are fairly complex just as a standalone position.  There also is the possibility that this is a hedge or combination with another position on the BKX, its options, or other indexes, ETFs, or stocks.

It will be interesting to see how this trade (based on the information we have) plays out. 

Disclosure: No positions.

Stocks: RKH, KBE, XLF